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State Tax Competition is Both Good Policy and It's Constitutional

Tax policy is one of the ways in which the states compete to enhance the welfare of their residents. Ideally, states would compete simply based on overall low tax rates, rather than the legislature carving out special areas for favored treatment. But in practice that has never been the case. For example, states commonly use tax credits, which mitigate the harm of high tax rates, to compete against each other. They also use tax breaks to lure capital investment and other activities that they presume are valuable.

Some see this competition between the states as needless friction and are calling for a federal law to restrict states from tax competition. Emily Badger of the Washington Post writes that “Economists have repeatedly concluded that the incentive game is zero-sum: Most jobs and economic development created by incentives in one state or community are simply lost in another. It's also exceedingly difficult to pin down data on whether a public investment to lure a company is ultimately worth it. While there's often big fanfare around the announcement of such deals, there's seldom much attention on assessing their promises in hindsight.”

However, as she points out, the same people who criticize such tax incentives would allow them for purposes for which they approve, such as “cleaning up a brownfield, “helping an ex con get a job” or “bringing a grocery store to a food desert.” All nice goals, but the argument highlights just how a federal law would leave room for social manipulation while excluding the more critical function of attracting investment and enhancing economic growth.

Those who favor a system of federal tax policy controls claim that state governments are horrible at financial decision making, often gaining nothing while giving away tax revenue. Yet, the federal government is demonstrably worse than the states at fiscal management and, while never mentioned in the article, our Constitution has something to say.

The U.S. Constitution empowers states as the primary political entity. The states, and the people, created the federal government and placed broad restrictions on it. Given this fact, it is appropriate for state government to operate in the best interests of its citizens as expressed through those elected by the people of the state.

The Tenth Amendment codifies what was widely recognized at the time: namely, that states are free to act in matters the Constitution has neither delegated to the federal government nor prohibited the states from undertaking. Although the Constitution prohibits some state actions—e.g., declaring war or coining money—they have wide discretion to engage in such activities as building and operating their own infrastructure, regulating their own affairs and imposing their own taxes for their own purposes. And the Constitution certainly does not empower the federal government to turn the states into a de facto tax cartel.

So solutions to state tax problems should be resolved within the state. The powers not delegated to the federal government don’t belong to it; that power belongs to the states or the people.